In an economy, the government wants to increase aggregate demand by $48 billion at each price level to increase real GDP and reduce unemployment.If the MPC is .75, then it could:
A)reduce taxes by $12 billion.
B)reduce taxes by $16 billion.
C)reduce government spending by $12 billion.
D)increase government spending by $18 billion.

Question

Quizplus · Accepted Answer

Given that MPC = 0.75, we can use the formula ∆Y = (∆Spending)/MPS where ∆Y = $48 billion and MPS = 0.25 (since MPC + MPS = 1). Solving for ∆Spending, we get ∆Spending = $192 billion. Since the government wants to increase aggregate demand, the best option is to reduce taxes, which is a form of fiscal policy. Using the formula for the tax multiplier (-MPC/MPS), we can calculate that a $16 billion reduction in taxes would increase spending by $48 billion, which meets the government's objective. Therefore, the best choice is to reduce taxes by $16 billion.

In an Economy, the Government Wants to Increase Aggregate Demand